Consumer advocate Barbara Roper, who recently received the Institute for the Fiduciary Standard’s annual Frankel Fiduciary Prize, knows a thing or two about the investment industry.
I had the honor of sitting down with her for an interview (see “Exclusive Interview: Barbara Roper Says Mere Disclosure Inadequate for Fiduciary Advice,” FiduciaryNews.com, October 17, 2017). She mentioned one thing in particular that set those dusty gears in my head awhirlin’.
In distinguishing the difference between brokers – specifically, brokerage services – and advisers, she bluntly said, “This isn’t the 1930s. We don’t need licensed professionals to help us ‘effect transactions’ in securities. We can do that for ourselves with a few clicks of the mouse.”
As all professional investment advisers know, this is the barren truth.
That’s why you don’t see portfolio managers caught up in the fray of this “fiduciary/conflict-of-interest” debate. The simple fact is their business isn’t threatened.
Portfolio managers don’t sell products — they analyze securities and construct, maintain, and manage portfolios of those securities. They get paid on their ability to increase client worth (at the risk of having their pay reduced if, even should it occur through no fault of their own, client worth decreases). They aren’t financial planners, they’re portfolio managers.
It seems the focus of the fiduciary debate resides between financial planners who render investment advice on third-party products and financial planners who sell financial products. The former are registered investment advisers while the latter are licensed brokers.
Through the magic of both dual registration and the anomaly of the English language, there’s nary a distinction between the two. In the former case, the SEC permits individuals to wear both hats without enforcing clarity regarding which hat they are wearing when they speak to clients. In the latter cases, while only RIAs can call themselves “advisers,” anyone can print the word “advisor” on a business card.
The fact that one regulatory regime is more restrictive than the other explains the fundamental nature of this ongoing battle. The SEC holds RIAs to a best interest standard while brokers are held to the much looser suitability standard.
Yet, for all intents and purposes, they appear to be offering the same service. That’s not a level playing field. That’s not fair.
Brokers migrated to the advice industry because their own hunting grounds became fallow. Facing the deregulating of stock commissions, brokers saw their high margins evaporate. They were forced to find greener pastures, and rendering investment advice was the greenest pasture of them all.
Traditionally, before the dominance of mutual funds, the RIA industry was almost solely limited to portfolio managers. It was a refined job best suited for those mathematically inclined, though the math was not as rigorous as that used by quantum physicists (despite attempts to make it so, as any derivative trader will tell you).
When mutual funds replaced individual stocks as the investment of choice, the door was open for financial planners to begin offering investment advice in earnest. And, as we know, financial planners can come from either the ranks of RIAs or the halls of the brokerage industry.
Soon, portfolio managers lost their exclusive claim to the mantel of “investment adviser” (or “advisor”). Think about it. When the newspaper seeks a professional for a quote on an investment, who do you see more often – a financial planner or a portfolio manager?
Did this evolution from broker to financial planner advising on investments obviate the need for brokers as Roper implies? For all the talk and speculation about the rise of the robo-advisor, is the real story how the robo-broker has replaced the human broker?
Most portfolio managers trade via computers, just like most everybody else. They don’t fear the computer because these machines have yet to threaten their livelihood. Despite rumors to the contrary, passive investing will never replace active investing (mostly because passive investing itself is not a sustainable model, but that’s a story for another day).
As a result, while some investors will adopt a do-it-yourself approach (either because of ego or to save money), many others will accept the need to delegate managing their portfolios to those who specialize in securities analysis.
The same can’t be said of those who merely rearrange the deck chairs on the good ship Asset Allocation. This is why investment fees for those advising 401(k) plans are a mere fraction compared to the fees of portfolio managers.
As those fees have come down (and they have), business models have had to be changed. In the old days, RIAs could survive by maintaining a small capacity. Today, in order to pay the same infrastructure costs, RIAs need to maintain a much larger capacity (which, ironically, risks driving up infrastructure costs).
The need to expand their markets conflicts precisely at a time when broker financial planners are entering those same markets. This is what makes the unlevel playing field relevant.
Can brokers merely be reassigned their old jobs of taking orders? This is unlikely. In the 401(k) world, that job has been fully automated and not by brokers, but by plan recordkeepers.
Brokers have no choice but to transform into RIAs. The brokerage business model is unsustainable in the long-term.
At least within the retirement plan market.